Fuelled by loose monetary policy, fixed income managers have had a tailwind for the past ten years.
This tailwind is changing and managers are going to have to dig more into our own reserves to provide value for our clients.
Loose monetary policy has also increased bond market risk as duration has nearly doubled in the past ten years.
We believe investors in fixed income should employ a flexible approach based on the limited pockets of value that we see in the overall asset class.
Among an expensive bunch, our favourite government bonds tend to be US dollar-denominated. The US central bank has at least managed to raise interest rates to a level that is closer to a fair value that can be meaningfully cut in a pinch.
Our favourite corporate bonds are in high yield, and again we prefer US dollar-denominated. We believe the US economy remains in good shape, which bodes well for low default rates to continue, or at least not spike to dangerous levels.
High yield bond spreads offer reasonable long-term value and protection against defaults.
I use this enthusiastic but not table-thumping description as 2019 has thus far provided strong high yield returns. We were not far from table thumping at the start of 2019.
To avoid accumulations of thematic risk, such as exposure to the oil price, we believe in a highly active, concentrated approach. A zero weighting to whichever sector is okay by us.
After years of loose central bank monetary policy, we view most other fixed income assets as generally expensive and riskier today than they were a decade ago.
UK gilt yields, for example, in our view do not provide adequate compensation as a store of value against inflation. We believe this to be true irrespective of hard, soft or no Brexit scenarios.
At an approximate 0.25% yield, German 10-year Bunds are even worse, with German inflation running at 1.5%.
In nice round numbers, other things equal, Bunds are likely to erode 1.25% of the buying power per annum for the next ten years.
Holders may well be owning them as insurance against riskier assets falling in value, but we see this as very expensive insurance indeed.
Donald Phillips is co-manager of the Liontrust Strategic Bond fund
• High yield 'spreads' are attractive and will be more so when they approach 5%
• Stockpicking in high yield can build a portfolio of high-quality business
• Gilts offer poor compensation versus UK inflation, while Bunds are even worse versus European inflation
• Bonds in general are more risky than they were ten years ago as bond index duration has nearly doubled